More Prep Needed for College-Planning Test

Christine Benz: I'm Christine Benz for Morningstar.com. Average college-savings account balances were up nicely in 2013 from the year before. Joining me to discuss this and other news in the realm of college funding is Adam Zoll. He is assistant site editor for Morningstar.com

Adam, thank you so much for being here.

Adam Zoll: Thanks for having me.

Benz: Sallie Mae does this study annually looking at how people are saving for college and how much they've saved. You say that the most recent survey actually shows some pretty encouraging trends.

Zoll: There are some encouraging trends in terms of the amount saved. First of all, the survey found that about half of all parents with children ages 0 to 18 are saving for college. That's held steady since the previous year, but the balances are up about 30%. First of all, the amount that people on average are contributing to college savings averages about $3,400 per family. That's up about 30% from the year previous. And the overall balance, which stands about $15,300, is also up about 30%.

We're coming off a year with very strong stock gains; that probably played a role. But in general people are contributing more to college savings which is a positive development. Again $15,000 is not even going to pay for one-year of undergraduate education at an in-state public school, but at least people are focused on saving more for college.

But again, there's a real shortfall, a disconnect between what they're going to need and how much they are saving at this point.

Benz: Families still have some work to do. The survey actually unpacks where people are saving for college. You think that it's pretty interesting when you look at what vehicles people are using for their college savings. You think they could make better choices.

Zoll: Absolutely. The most commonly used vehicle to save for college is a general savings account. And anybody who has a savings account in a bank knows this is an account that's paying you right now probably less than 1%. When you talk about college savings, saving for a goal that may be 10 or even 18 years away, you really want to give your assets a chance to grow. The best way to do that is to expose them to stocks.

One of the problems with saving in a general savings account is you're really not giving your money much of a chance to grow. You're gaining the ability to withdraw that money if you should need it for an emergency for some other purpose. That's great to have that flexibility, but you are also not really allowing that asset to grow.

Another advantage that you're depriving yourself of is the tax advantages of accounts like a 529 college-savings plan, a Coverdell Education Savings Accounts, and even a custodial account. These are tax-advantaged savings vehicles that can allow your money to grow for college without having to pay taxes each year, and then when you take those distributions to use to pay for college, you're not paying any taxes. If you invest in a taxable account and put the money in stocks, those embedded capital gains are going to hit you with a tax bill.

The most efficient way to save for college is through one of these tax-advantaged accounts. You are sacrificing the flexibility of withdrawing the money if any emergency should arise, but you are gaining the potential to have a lot more saved up for college when you need it.

Benz: Switching gears, Adam, there are changes afoot for a test that we all remember taking as we got close to college. The SAT is making some changes. Let's talk about why they're happening and what the changes will be?

Zoll: That's right. The SAT is instituting some pretty fundamental changes. Part of it is because the SAT has been losing market share to the ACT in recent years, but also I think it's in response to some desire to provide some more real-world application for various academic skills.

For example, students previously were asked a question and provided an answer. Now they are going to be asked to sort of provide some information as to how they arrive at the answer. Where did you find evidence that supports the answer that you gave? So it's a little bit of deeper reasoning that's being tested here.

Another fundamental change, the SAT essay is now going to become optional. Students will not have to take it; however, some of the more selective colleges are expected to require or at least request that people do write the essay so that they can be sure that these people have strong writing skills. These are some very fundamental changes coming to the SAT for students who are going to be enrolling in college in 2017 or later. You want to be aware of these changes. Make sure that you're studying for the revamped SAT test, when the time comes.

You will still have the option of taking the ACT; that is not going to change. But definitely if you've got old study guides from an older sibling, for example, make sure that you are not working off of those and that you are working off what this new SAT test is going to be like.

Benz: These tests are getting even more important because in another study we see that the top schools, the most elite schools, are actually getting more competitive. Not only you need to do well on these tests, but you need to do well with everything else.

Zoll: That's right. The New York Times reported that during the most recent admissions period just the past month or two that Stanford had its lowest rate of admissions ever at 5%. Harvard and Yale accepted only 6% of students. This is happening for a variety of reasons. While the overall college attendance peaked recently, it peaked in 2011, these elite schools continue to draw massive amounts of students who want to enroll there. Enrolling is a lot easier than when we applied years ago and you had to fill out paper forms. Now it's all done online and makes it a lot easier to apply to a broader number of schools. But also the influx of foreign students has really driven up competition at these elite universities. People coming from overseas who want to go the best universities in the world. This is driving up demand. It's driving up competition. So, it's just gotten more competitive over the years.

Benz: For those students who finish their undergrad education and choose to go on to grad school, we see some troubling numbers about the debt loads that some of these students are shouldering.

Zoll: That's right. Debt from graduate school doesn't get as much attention as debt from the undergraduate level. But a New America Foundation study found that median debt for those earning graduate degrees in 2012 was about $57,600. That's up from about $40,000 in 2004, and that's even on an inflation-adjusted basis. In fact 10% of grads leave school owing more than $150,000, so you can imagine the sort of financial headwind that they're leaving school with.

The report also found that in 2012 about 40% of all college loans went to graduate students even though only about 17% of the borrowers were graduate students. So, clearly a lot of people are taking out loans to continue their education beyond getting a bachelor's degree.

Benz: When you look at this data, Adam, what's your takeaway? What should families or students who are thinking about embarking upon grad school be thinking about?

Zoll: I think one of the big takeaways is that thinking about college or post-secondary education as just a four-year experience is in many cases shortsighted. Sometimes students take five years or longer to graduate. Many students will need to continue their education and get advanced degrees beyond that. It's easy to focus on, especially as a parent, "How am I going to afford four years of college for my kid?" But you have to have a longer view.

If you think that graduate school may be in their future, maybe you don't want to pay for that pricey undergraduate experience. Maybe you want to look at a less expensive school, so that you can apportion your college-savings resources more equitably and save for the continuing education beyond a bachelor's degree.

Financial planner Mark Balasa and Morningstar's ChristineBenz and David Blanchett tackled viewers' most pressing retirement questions, from determining savings rates and income needs to planning for Social Security and maximizing retirement accounts.